MARKETS WAIT ON RESCUE PLAN -- S&P 500 NEEDS TO CLEAR SEPTEMBER PEAK TO CONFIRM A BOTTOM -- WATCHING THE VIX FOR MARKET CLUES -- HOUSING STOCKS SHOW IMPROVEMENT FOR THE FIRST TIME IN THREE YEARS -- SIT TIGHT
MARKETS ARE HOSTAGE TO GOVERNMENT ACTION... I can't ever remember a time when financial markets were so dependent on government action. Like everyone else, I watched with great interest the Congressional negotiations being played out behind closed doors (and in front of TV cameras). The consensus view is that a rescue package will be worked out by Sunday evening in time for the opening of Asian markets. Hopefully, that will give the markets a boost on Monday morning. How the markets would react to a failure to act, or a watered down rescue plan, is anybody's guess. One thing seems certain. Monday will be a very interesting market day. We, of course, don't like the markets being held hostage to government intervention. We are market analysts and prefer to take our cues from the markets themselves. With the full knowledge that government announcements will play a big role in short-term market action (as well as long term), the following comments are based on what I see on the charts at the current moment.
Chart 1
S&P 500 TREND IS STILL DOWN ... The previous week's upside reversal on record volume had the look of a possible "selling climax" bottom. Nothing that happened this past week changed that view. After a low-volume retracement over the first three days, the stock market bounced a bit on higher volume. That pattern is mildly encouraging. Having said that, the market's trend is still down. Chart 1 shows the S&P 500 ending the week slightly higher, but no short-term buy signal has yet been given. The 14-day RSI line (top of chart) is stalled at the 50 level. The daily MACD lines (below chart) have shown positive divergence off their July low, but have not yet turned positive. Most importantly, the S&P remains below its 50-day moving average. For a short- to intermediate-term bottom to be in place, the S&P needs to close above the previous week's intra-day high. Even that wouldn't signal a major bottom, but would increase the odds that a fourth quarter rebound has started. Bear in mind also that most bottoms take place during the month of October (and that most presidential election years end the year on a strong note). That leaves open the possibility for some short-term disappointment. Chart 2 shows a similar pattern in the Dow Industrials.
Chart 2
BANKS LEAD FINANCIALS HIGHER ... One of the more positive signs is continuing relative strength in the financial sector and banks in particular. Chart 2 shows the Financials SPDR (XLF) rising 2.7% on Friday to close back above its 50-day average. And it did so on rising volume. The XLF, however, remains below its mid-September peak and its 200-day moving average. It would have to clear those two barriers to improve its trend and that of the market. Chart 3 shows the PHLX Bank Index even closer to its 200-day average. On the previous Friday, the BKX closed above the 200-day line for the first time in a year. A repeat performance of that feat would be a positive sign for it and the market. Both relative strength lines have been rising since mid-July. That's an early sign that investors are turning a bit more optimistic on the financial sector.
Chart 3
Chart 4
BONDS STILL ON THE DEFENSIVE ... The late Friday bounce in stocks kept bond prices on the defensive. Chart 5 shows the 10-Year Treasury Note Price closing below both moving average lines. Bonds would be one of the main casualties in a government borrowing campaign to pay for the huge rescue plan. Chart 6 shows the US Dollar Index ending the week just above its 50-day line. That prevented gold from breaking through resistance at its 200-day average (Chart 7). It will be interesting to see how those markets react over the coming week.
Chart 5
Chart 6
Chart 7
VIX STILL IN UPTREND ... The CBOE Volatility (VIX) Index spent the week consolidating its previous week's gain. Its highpoint the previous week (42) was the highest reading since October 2002 (45). What the VIX does from here will tell us a lot about the market. Generally speaking, a rising VIX is bad for stocks, while a falling VIX is good. The daily bars in Chart 8 show the VIX trading above its July peak near 30 but below its early 2008 high. The hourly bars in Chart 9 show short-term support and resistance levels more clearly. A drop below 27.95 would be a positive sign for the market. A lower VIX is an important part of any market recovery.
Chart 8
Chart 9
HOMEBUILDERS MAY BE BOTTOMING ... During the summer of 2005, I started writing about a top in homebuilding stocks. An August 23, 2005 Market Message entitled "Housing Index looks Toppy" warned that homebuilders were giving major sell signals. A November 8, 2005 Message repeated that warning with the headline "Housing Index Peaked in June". That later message ended with the warning that could signal "the likely end of the five-year boom in housing stocks". Those messages also warned that a housing peak could have negative implications for the stock market and the economy. The weekly bars in Chart 10 show the 2005 peak in homebuilders and the sharp downturn starting in the spring of 2006 and mid-2007 (see arrows). That's where all the trouble started. I'm coming back to it today because things are finally starting to look a bit better for homebuilders. Just as the 2005 peak was an early sign of impending problems, this year's homebuilding rebound could be an early sign of improvement. For one thing, the HGX is trading back over its 40-week (200-day moving average) for the first time since mid-2007 (see circle). For another, homebuilders are starting to outperform the rest of the market.
Chart 10
HOMEBUILDERS SHOW RELATIVE STRENGTH ... Another positive sign is that homebuilders are showing the best relative performance in three years. The blue line in Chart 11 plots a relative strength ratio of the Housing Index versus the S&P 500. The ratio peaked in mid-2005 along with homebuilding stocks and declined steadily until the start of 2008. After forming a "higher low" during July, the HGX/SPX ratio has risen to the highest level in a year. That's the best relative performance since the housing mess started. The ratio is now challenging a major resistance line going back to the 2005 top. A move above that important barrier would be further evidence that the situation in housing may actually be improving. This may seem heretical given the current pessimism on the housing situation. That pessimism, however, is matched by the level of optimism that accompanied the 2005 peak.
Chart 11
SIT TIGHT ... Our long-term readers know that we started to warn of serious market problems a year ago and recommended taking defensive action to protect against a coming bear market. Over the last month, however, I've recommended doing nothing. I've expressed the view that it's too late to sell and too soon to buy. I still feel that way. Those looking to do some selling might be better served waiting for a fourth quarter bounce to do so. Those looking to do some buying need more convincing signs of a market bottom. At such times, it's usually best to sit tight.
